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Kevin Kersten's Analyst Insights

September 16, 2013 - A Different Strategy to Power your Portfolio

There has long been a dream of a few solar panels on your roof providing lots of cheap clean power. There is something appealing about being free of the grid, not dependent on the power company and not having to pay an electric bill every month while knowing that your power comes from a clean, renewable source.

While solar technology is coming of age it still is unlikely to transform the way most of us live. Homes can use a lot of electricity between electric stoves, electric heat, air conditioning, hot water heater, microwave and clothes dryer. While it is possible to cut the cord, it usually takes more than most of us are willing to do. There are people who have off-the-grid cabins and live quite comfortably, but they are rare. The most cost-effective way is to cut power use down to a minimum by substituting gas appliances and highly efficient lighting. Proper home design and good insulation can save a lot on heating and cooling costs. Homes designed with lots of natural lighting, proper airflow, and rooms designed to take advantage of season can result in being comfortable with little use of power.

Many times existing homes are not easy to retrofit and even new homes can be provide difficult choices. Solar Panels on the roof need direct sunlight, but that sunlight can warm the house and drive up cooling costs. High ceilings that provide a cooling effect in the summer, increase heat requirements in the winter time. Large southern windows that can capture solar warmth in the winter, also bring in heat in the summer. There are many creative solutions for these problems such as putting solar panels on a garage roof, putting curtains on windows and designing rooms differently. But when it comes to the bottom line, central air conditioning with a grid hookup is pleasant and convenient. That is why many people have looked at solar power as supplement and not as a replacement. It is nice to have power at night and on rainy days as well.

Solar has seen lots of advances in the last few years although it has fallen out of favor with investors in recent years. Solar cell prices have been dropping as a glut of solar cells have hit the market. Prices fell 41% in 2011 and 31% in 2012. The number of companies making solar panel in China fell from 900 to 700 last year as many were bought out or went bankrupt. Natural gas discoveries have pushed the price of conventional fuels lower, making solar less competitive with fuel efficiencies of traditional power plants.

Governments in Japan, Europe, China and America have been subsidizing solar power with special tax incentives. China just passed a long term incentive plan that makes solar a viable business model and should allow plant operators to make a long term profit. Some of the solar projects make sense and as prices continue to fall and technology continues to improve there is great hope a transformation is about to take place. Solar panels provide power during peak mid-day load times when it is needed the most and can provide it closer to the point of use. This can have a positive balancing effect on grid demand. Mass solar power plants can also be located in deserts or away from the city making installation and maintenance easier.

Trina Solar Limited (TSL) is one of the big solar companies in China. The stock trades on US exchanges with American Depository Receipts. One could make a good argument that now is not the time to invest in solar. The company is losing money as profits are down, The stock lost $3.77 per a share last year and is expected to lose about $1.27 per a share this year. The company is short on cash and has significant short and long term debt. The stock has ranged from $2.04 to $11.36 over the last year and about three years ago was above $20 a share.

On the other hand the market appears to be turning around and profits are improving. The company has a lower production costs than competitors. With subsidies stabilizing around the world and competitors failing, production may match demand and there is potential for having one of the winners of tomorrow.

Most investors may stick with the traditional approach with a solar company. Knowing it is a risky stock they buy a few shares into portfolio and hold on for the long term and hope the stock goes up. Buy and hold investing is a proven method. Covered call investing is usually done on stable dividend paying stocks, but it can also be done on a high flying solar company like TSL as a way to lower your risks.

The TSL stock is trading near 11.57 and December 11 call is going for 2.02. That means the covered call trade can be entered for a 9.52 net debit (11.57-2.02). The trade has a 15.5% (11.00-9.52)/9.52) return over the next 101 days. This means the trade has a 55% annualized return rate and 15.2% of downside protection.

Investors who have held onto this stock for 5 years have not seen huge returns and while there has been a nice move up in the last year, there are still underlying issues that are not going away. Rationalizing our return expectations can give us a trade we might not otherwise think about. The huge risk premium on the stock indicates it has risks. However, one can book some bigger cash. A 55% annualized return rate (for comparison purposes only) is really good for a covered call.

Investors can find a balance in their portfolios by holding some stocks long and managing others to generate extra cash with a covered call. A volatile past and 15% of downside protection can actually make the covered call return much higher but it has much higher risk as well. Consider mixing your approach and look to book some cash on these stocks while there are still rich premiums in the options.